June 2001

A recent drop in the markets caused a loss in your account balance, and you realize you may not have enough for retirement. How do you find out if your nest egg will be large enough?

To answer this question, investors of all ages are turning to web-based financial planning tools. Investment calculators or planners let you estimate how much you might need for retirement. However, not all retirement calculators are created equal.

According to Russell Investment Policy & Research (IP&R) analyst Paul Bouchey, investors need to pay close attention to two things when using any web-based financial planner: estimating how long you plan to live in retirement and projecting realistic investment returns.

According to Bouchey, many retirement planning tools suggest that you use your life expectancy, as determined by insurance company tables, to plan. For example, a 60 year-old with a life expectancy of 83 has a twenty-two year planning horizon. The planner calculates how much you’ll have per year to live on in retirement until you reach age 83. Once you reach age 83, the planner assumes your retirement savings is gone. So what happens if you live past 83? According to Bouchey, investors have a 50% chance of outliving their life expectancy figure and as a result, their retirement savings. That’s a scenario none of us want to be in. To avoid this, investors should plan to have retirement assets that can outlive their life expectancy.

Secondly, most retirement planning tools ignore the uncertainty in portfolio returns. So, when you create a retirement target amount, build in a reserve, or plan to leave an inheritance. Having a reserve built in to your plan may result in a successful plan despite poor markets. Investors too often make the mistake of altering the rate of return in the planning tool in order to make up for a retirement shortfall. You can change the rate of return in a retirement planner, but no one knows what returns will be in the future. Bouchey suggests that you should use an 8% rate of return and not 12% or 15%, saying it’s better to be on the conservative side when projecting returns then ending up with a retirement shortfall.

In deciding which web-based planner to use, Bouchey recommends that you to look for a high level of detail in the questions being asked. It should ask for a complete financial picture such as your 401(k) balances, IRA’s, pensions, Social Security and additional savings accounts. Once you find a planner you’re comfortable with, develop a savings plan based on time horizon, tolerance for risk, and the ability to contribute for the long term. Remember to use the tool if your financial or life’s circumstances change. Most importantly, stick with the plan through bull and bear markets.